Why It’s So Hard to Choose ESG Funds and ETFs

Choosing a fund or ETF with a positive environmental, social and governance (ESG) profile is fraught with risk. New research shows how carefully investors must weigh considerations such as screening criteria, factor exposures, industry concentration and expenses.

Concern over climate change has led many investors to consider integrating carbon risk into portfolio and risk management. Maximilian Görgen, Andrea Jacob and Martin Nerlinger, authors of the study, “Get Green or Die Trying? Carbon Risk Integration into Portfolio Management,” published in the February 2021 issue of The Journal of Portfolio Management, examined how integrating carbon risk impacts portfolio risk, exposure to common factors (such as value) and performance.

In their June 2019 study, “Carbon Risk,” the authors had quantified carbon risk via a “Brown-Minus-Green factor” (BMG) which was derived from 1,600 firms with data from four major environmental, social and governance (ESG) databases. BMG is “a composite measure of three indicators designed to separately capture the sensitivity of firms’ ‘value chains’ (e.g., current emissions), of their ‘public perception’ (e.g., response to perceived emissions), and of their ‘adaptability’ (e.g., mitigation strategies) to carbon risk.”

The BMG factor enabled Görgen, Jacob and Nerlinger to construct quintile portfolios and analyze the implications for portfolio management. Their analyses were based on a global dataset consisting of all constituents of the MSCI ACWI Investable Market Index (IMI) for the period October 2010 to December 2019. The sample included almost 9,000 constituents and approximately 99% of the global equity investment opportunity set.